Banking Regulation: A Case Study

Hello,

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Pierre and I will be arguing in favour of the statement: Banking and international capital movement should be strictly regulated. I’ll be mainly focusing on banking regulation. In specific I’ll discuss the uniqueness of the banking sector, the representation hypothesis, social externalities, moral hazard and the failure of deregulation.

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We seek to regulate the banking sector, more strictly than we do almost any other industry because it is simultaneously vital to the global economy and susceptible to systemic failure arising from the interconnectedness of its individual banks.

Banks allow borrowers and investors to form links through transactions from around the world, facilitating the transfer of money from

When one person is making a decision from which the fallout will only, or largely, affect someone else there is the potential for moral hazard. In banking, an example of moral hazard is when a bank invests depositors’ money in a way that they would be less inclined to do if it was their own money, due to the risk involved. Some regulations that help to reduce the risk of bank failure in other ways actually increase the risk of moral hazard occurring. The government guarantee of deposits is such a regulation. Under a government guarantee of deposits the bank knows that not only is the money they’re risking not their own, but also that if they do lose the money the government will cover either all or a portion of the loss depending on the details of the particular

If a bank invests heavily in one asset, they might make very large profits or losses depending on how the asset performs. If a bank invests in several different asset classes, then if one asset delivers a loss, it will hopefully be offset to some extent by an asset that delivers a profit. By limiting how much a bank can invest in a single investment, asset-class restrictions encourage a bank to diversify its portfolio.

Risk-based deposit insurance works similarly to how car insurance works. With car insurance, a driver is deemed to be at higher risk of being in an accident for various reasons from their age to whether they have previously been in an accident. Their premium is higher if they are deemed to be at a higher risk of being in an accident. Similarly, under risk-based deposit insurance, a bank pays a higher premium if they are deemed to be at higher risk of losing their depositor’s money.

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